401k Contributions: Why I’m Re-Starting Mine (April 11, 2014)

Last year, around June timeframe, I decided to stop funding my 401k. Since I’ve been working full-time in industry, I have always made a conscious effort to contribute to the 401k each and every year. As of April 2014, I have contributed $0 to this year’s 401k.

That is all about to change. Just recently, I elected to re-enroll back into my company’s plan, and may very well end up contributing up to the max this year.

So, why the sudden shift in my investment philosophy?

Accomplished Last Year’s Goals

In June 2013, I owned two rental properties and was working on closing Rental Property #3. I knew that I wanted out of the rat race, and I realized I would need a lot more passive income to make early financial independence possible.

By stopping my 401k contributions when I did, I was able to basically save those retirement pennies, and instead funnel it into my downpayment fund to help purchase Rental Property #4 and Rental Property #5.

Today, I own five properties, and am getting closer to reaching my early FI passive income goals. One of my focuses for 2014 is to slow down the speed of acquisition and to focus more on building cash reserves. In other words, I’ve done the bulk of the heavy lifting (2012-2013), and don’t need to buy more properties at such an accelerated rate anymore.

At most, I’ll purchase one additional rental property this year. Further, I may even elect to sell Rental Property #1 this summer, which should make it possible for me to do a 1031 exchange into multiple properties (4-5 would be my guess). Selling Rental Property #1 will shortcut a lot of the acquisition work I would have otherwise had to fund myself.

As a result of all this, I may not have to save as much as I originally thought I would. Further, I have a lot of stock options and RSUs vesting later this year. This provides additional funds to help replenish the cash reserves.

Tax Shelter

The most important reason why I’m re-starting my 401k contributions is that I need the tax shelter that it provides. Just recently, I did my taxes for 2013, and the results weren’t so pretty. I owe Uncle Sam several thousands of dollars as a result of capital gains from last year… Also, because of my higher income bracket, I wasn’t able to fully maximize my rental property deductions.

That was a sinking feeling… And I would imagine my adjusted gross income being even higher in 2014 (even a measly 2% pay raise doesn’t HURT my income). So, I’ll need to take advantage of my 401k plan to help reduce my taxable income as much as possible. By contributing to the 401k, I will also be able to get in on the company match again. This is free money, after all, so I might as well take it. 🙂

Summary

I’m getting closer to declaring early FI. The last piece I need to move to make early FI a reality is to sell Rental Property #1 and perform a 1031 exchange into multiple properties out-of-state. If I can succeed in accomplishing that (either this summer or summer 2015), I should have sufficient income to not only cover all my monthly expenses, but enough left over for capital reserves (properties) and even some for investing back into dividend stocks.

As such, I don’t need to go gangbusters in trying to acquire more and more properties. At most, I will purchase one more property this year with my own funds.

I’m planning ahead, but right now I don’t see the immediate need for more capital. Couple that with the tax shelter and free company match a 401k offers, and my decision to re-invest back into my employer’s plan becomes a no-brainer.

Preview of Things to Come

I like to provide readers an insight into my future plans, and current line of thinking. My plans are ALWAYS subject to change (I can’t control what the markets will do in the future), but I feel like it’s more beneficial to discuss them in real-time, as opposed to after the fact.

The following is what I see happening if everything were to unfold perfectly…

I call it the 3x Rule for funding early financial independence through real estate investing. The 1x is to meet my monthly expenses. The 2x is for capital reserves. The 3x is for more savings/investing.

Semi-Passive Income Target: $4500/month

1x: Monthly Expenses: $1500/month
2x: Capital Reserves: $1500/month
3x: Savings/Investing: $1500/month

1x: It’s still preliminary, but right now I don’t anticipate needing to spend more than $1000/month while I’m overseas. The extra $500/month here is to provide some more cushion, in case I do occasionally splurge here and there. If I don’t end up spending more on a given month, I’ll simply invest the excess into dividend stocks, or savings.

2x: Also, the $4500/month semi-passive income target is the combined net cash flow from all properties in a given year. The net cash flow takes into account small maintenance and vacancy/eviction items. The $1500/month allocation is for capital reserves; these are the big ticket items: roof, furnace, emergencies, etc.

3x: Any remaining cash flow will be saved and invested into dividend stocks. If the stock market is especially HOT, I may elect to just park money on the sidelines temporarily, but the plan for now is to keep on investing even after early FI. Worst case, the 3x will serve as an emergency-emergency fund for the rental properties…

Thanks for reading! 🙂

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SeandaveThe First Million is the HardestNo Nonsense LandlordFI Fighter Recent comment authors
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writing2reality
Guest

Sounds like a pretty solid plan to me FI. I think the 3x portion should be more than enough to cover unexpected expenses, either personal or rental related, as well as continue to grow your assets and streams of income as you enjoy FI.

JC @ Passive-Income-Pursuit
Guest

Just curious with the 1031 exchange does that have to all be completed in the same tax year or can you spread the proceeds from the sale into multiple tax years?

It definitely looks like a solid plan and the 3x rule is a great idea. I’ve been thinking about how much cushion I’d want between my PI and expenses and while I don’t think we’ll get up to 3x, 1.5-2x is probably where we’ll end up.

writing2reality
Guest

Only my understanding of the rules, but 1031 exchanges generally need to be completed within a 180 days of the transfer of the original property, but is limited to the following tax year’s filing deadline. This means that any exchanges started before October 17th will get the full 180 days, and any after that date will get until April 15th. Everything must be done in this time period.

Leigh
Guest

🙂

I may drop my 401(k) contributions down to the minimum to get the match next year at the beginning to pay off the mortgage a bit earlier, but I would still max it out for the year. The $17,500 is really only $12,600 of post tax money, so it isn’t missed that easily.

I think I would probably want a $500/month cushion when I do quit.

Financial Samurai
Guest

I’m glad you are recontributing to the 401k man. It really adds up over time, and it’s a great way to DIVERSIFY.

What is your current net worth percentage allocation now?

FFdividend
Guest

I really like the plan. Wish you the best and good luck.

Done by Forty
Guest

I don’t know the specifics of your tax situation, but in general it’s a pretty good idea to shield the $17.5k if you can still accomplish your other financial goals with what’s left. There may be some opportunity costs as you’ll have less to throw at a future property, but the tax savings are a risk-free return on your money right now…depending on your tax bracket, they could provide an awesome return just from that.

No Nonsense Landlord
Guest

I always contribute the maximum, $23K for me, and have it completed by the end of February or middle of March. It will also teach you how to live on less income. when is 75 percent of your paycheck goes to your 401 K you will learn to live on a lot less.

The First Million is the Hardest
Guest

3x rule sounds like a good plan. Glad to see you’re investing in a 401k again, not only will it help your tax bill but it’ll be a good safety net to have if you ever need something to fall back on in your later years.

dave
Guest
dave

Its just hard to beat the 401k…you can save, get a guaranteed match, tax deferral, lower your current years income tax liability, borrow against it if need be, and roll it over into a IRA when you change jobs…not sure why so many bloggers avoid using it, or only contribute to the minimum required.

dave
Guest
dave

oh yeah, forgot to add, a 401k has more protection in court than IRAs or more personal type savings…so if you get sued, or divorced, judges are usually loathe to touch someone’s retirement accounts

Sean
Guest
Sean

I worry about 401K’s this year in this market environment. While dollar cost average is important and some people crave the discipline that a planned 401K contribution takes, If I contribute my max $20+K this year directly into a burgeoning Bear Market, any tax deferral advantage is negated by immediate losses. It still always pay to buy low and sell high. I plan to wait until the next market correction and then immediately start max contributions again, whether that happens in 2014 or early 2015 is to be determined.

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